governance, political economy, institutional development and economic regulation

Border controls across India’s 30 states fragment it economically. The Arvind Subramanian Committee Report, 2015 on Goods and Services Tax-GST, cites economic fragmentation as responsible for 15% in welfare loss. Hopefully, with the GST legislation on its way, the sight of trucks waiting patiently to pay tax will disappear. Photo credit: http://www.thehindu.com

Expectations are unrealistically high from the long delayed move to amend the Constitution and levy a common Goods and Service Tax (GST- a value added tax) across the Union and all state governments. Truly, this tax can bind India far better than Bollywood or the All India Services have done thus far.

Like the proverbial blind men describing an elephant, each segment of stakeholders see only how the GST could benefit them. Consumers eagerly await lowered retail prices once the pancaked tax embedded in the value chain can be set off.

Suppliers hope that lower tax incidence will enhance their competitiveness versus imports. Studies suggest welfare gains of five percent by reduction within state transaction cost and as much as 15% for supply across state borders.

Tax payers are ecstatic at simplification — the clubbing of more than a dozen individual taxes into a single tax.

The government looks forward to additional tax revenue from better tax compliance on a tax base made larger by higher economic growth.

Governance evangelists are pleased at the potential of reducing corruption, inherent in diluting the incentive to evade tax. This will build on the existing mission to make tax regimes transparent and accountable. Indirect tax revenue grew 29% in the first quarter of this fiscal year, despite merchandise imports contracting by 14% — a tribute to efficient tax collection.

Unemployed students and their parents look forward to a revival of industry and more “good” jobs thanks to efficiency led higher economic growth.

Road freight transporters await the benefits of reduced transaction time and cost. Today 25% of a trucker’s time goes in just waiting at border Octroi posts.

But reality will bite

However, several of these expectations are unlikely to be met over the next three years. There is a trade-off between enhancing tax revenue for the government and reducing prices for consumers or costs for suppliers.

There is also a trade-off between making the GST comprehensive, thereby plugging tax evasion opportunities and shielding small tax payers from the cost of compliance to become a part of the digital audit chain. Eighty five percent of the 9.4 million taxable entities are small, with an annual turnover less than one crore Rupees.

Ensuring that no state government is harmed, also called revenue neutrality, poses the risk of pegging the tax rates so high that they constrain demand and pass no benefit to consumers. Alternatively, the government has to breach the fiscal deficit targets to finance the compensation, but risks stoking inflation.

The Arvind Subramanian Committee Report of 2015 discusses all the trade-offs, pitfalls and optimal options. It is a must read for those interested in an informed appreciation of the issues involved.

Federalism — the real winner

The real winner has been the principle of federalism which has been visibly and practically implemented in public interest. The continuous work on the GST spanning a decade and the directional consensus across three separate Union governments and similar changes within the state governments is heart-warming for all those who would like India’s commitment to federalism, to be more than skin deep.

Similarly, political parties evolved a consensus in Parliament (even the AIDMK’s opposition was muted to walking out, but not voting against the motion) to pass the one hundredth constitutional amendment illustrates that plural and inclusive democracy is vibrant in India.

Naysayers opine that political parties may agree to a generic, enabling provision such as this one, but they will be pricklier when it comes to putting flesh on the bare bones. They may be right. But all negotiations have to begin by defining the envelope within which there will be give and take. This is exactly what happened in Parliament on August 4 last week. Now after a simple majority of the State Assemblies give their assent to the Act, it will be ready to be presented to the President of India to become the law.

Thorny issues remain

However, thorny issues still abound — defining the tax base and thereby the exemptions to be allowed; specifying whether the exemptions are indefinite or have a sunset clause; setting the tax rates for the Union and the States; identifying the existing Union and state government taxes which will be rolled into the new GST; writing up the new model law; specifying the principles for tax assessment and to identify the place of supply at which the new tax becomes payable.

All these are to be worked on by a newly constituted GST Council consisting of all the State Finance Ministers and chaired by the Union Finance Minister. This institutional innovation embeds the concept of federalism even deeper.

The process of rolling out the GST will require a great deal of analytical legwork of the type done by the Subramanian Committee; intensive monitoring of the IT backup for extending digital invoicing and tax payment and coordination of activities across the state governments.

Attempting all this from within the Revenue Department of the Union Government would be an unbearable burden. It would distract from the just-as-vital task of actually bringing the bacon home — enhancing tax collections to 13% of the GDP from 11% today. It does not help that the Revenue Department gets swamped over for at least nine months by the annual budget process.

GST Secretariat

A stand-alone GST Secretariat with a defined budget and human resources can hasten the pace. The Council and its Secretariat could be attached to the Department of Revenue of the Union Government for administrative and budgetary purposes. But, it must have a level of autonomy if its deliberations are to be credible.

The experience with exclusively Union Government staffed secretariats, servicing federated institutions, is not encouraging. The Planning Commission failed to be a credible secretariat for the National Development Council. Its successor — the NITI Ayog — is a Union Government think tank. The Home Ministry based Inter States Council suffers similarly from a Union government bias.

The GST Secretariat should be a mirror of the federated GST Council itself — staffed by officers drawn directly from the state governments and the Union Government. In deference to the pre-eminence of the Union Government, it should be helmed by a Secretary General proposed by the Chair. But in the spirit of true federalism, all senior appointments should be ratified by the Council members.

The Secretariat should be lean and skills based, not exceeding 100. The officers nominated by the States should be paid by the state governments. They would represent state government interests even as they work for the Council. Having both, ministers and senior officers from state governments, represented in the Council and its Secretariat respectively, is federalism at its best. The ensuing bottom upwards consensus will facilitate time bound decision making. This may be a baby step for federalism, but it is a huge leap for indivisible India.